The Power of Alliances

Research on U.S. firms shows how alliances formed by managers and workers affect the balance of power between managers and stakeholders

By Jaymee Ng, Principal Writer, China Business Knowledge @ CUHK

Conflicts of interests among managers and shareholders are inevitable at public corporations. For a company to continue to grow, maintaining a balance of power between the two is key. However, we often overlook another important stakeholder who can alter such a delicate power balance – the employees. 

“We find that substantial employee voting rights exacerbate the manager-shareholder conflicts,” says Prof. Wang Cong, Associate Director of Shenzhen Finance Institute (SFI) and Professor at the School of Management and Economics at The Chinese University of Hong Kong, Shenzhen. 

Prof. Wang is referring to his recent research study entitled Employee-Manager Alliances and Shareholder Returns from Acquisitions conducted in collaboration with Prof. Ronald W. Masulis at the University of New South Wales and Prof. Fei Xie at the University of Delaware. 

In fact, there has been a growing interest in research regarding the importance of employees’ influence in corporate policies and outcomes. 

Previous studies have established that employee equity ownership can lead to undesirable acquisitions, especially when their interests are in line with the managers’ interests. It has been studied that workers could use their voting power to protect managers from hostile takeover situations in exchange for satisfactory salary and working conditions promised by the management. If this alliance is formed, managers are likely to pursue empire-building acquisitions that serve his or her own personal interests and destroy shareholders’ interests. On the other hand, an alliance can be formed when managers and workers have large portions of their wealth tied to the company. In this situation, the worker-manager alliance would allow them to choose acquisitions that provide more employment security and shareholders’ interests would be the least of their concern.

In their study, Prof. Wang and his collaborators explore the potential for manager-worker alliances when employees have substantial voting power due to their equity ownership in their firm. Such equity positions arise primarily from employee stock ownership plans (ESOPs) and 401(k) plans, and occasionally from profit sharing plans and stock bonus plans. 

“We enhance our understanding of employee influence in firms by taking a broader perspective on the dynamics among these three key corporate stakeholders and their distinct economic interests,” Prof. Wang explains. “More specifically, we recognize the potential conflicts of interests between shareholders and managers when interacting with employees. We explore the possibility for workers and managers to form alliances and examine how such alliances affect the agency relationship between managers and shareholders.”

The Study

For the purpose of the study, the team construct a sample of 3,778 acquisitions made by firms in the Institutional Shareholders Services (ISS) database between 1996 and 2009 in the United States. According to the results, the presence of a 5%, 10%, and 15% of employee stock ownership reduce acquirer returns by about 0.859%, 1.388% and 2.429% respectively, which represent losses in shareholder wealth of $73 million, $118 million and $207 million respectively. In addition, when employees control more than 15% of company shares, they can almost block any unwanted takeover attempts. 

“Our results are consistent with the interpretation that workers use the voting rights from their equity ownership to deter outside control challenges, thereby allowing managers to consume more private benefits at shareholder expense. However, it may seem puzzling why workers would align themselves with managers and allow empire-building acquisitions to occur, especially considering that such acquisitions can cause employee shareholdings to lose value and even undermine employee job security if they lead to restructurings and layoffs,” says Prof. Wang.

Based on the worker-manager alliance theory by Pagano and Volpin, the team conducted further tests with their data to investigate whether it is beneficial for employees to support their managers in empire-building acquisitions. 

The results show that each employee loses $88 due to the acquisition’s negative effect on employee shareholding but he or she can receive $2,383 per year in excess wages for the same average acquirer, which is an irrefutable evidence that employees would benefit by supporting empire-building managers. Furthermore, such alliance is more likely to be found in companies that practice labour-friendly policies, more unionized workforces, abnormally high employee wages and when employees’ employment status is less affected by poor managerial decisions.

“Again, these results are consistent with the argument that managers can forge an alliance with workers by offering them generous wages and in return workers are willing to use their substantial voting rights to protect managers from unfriendly takeover bids. As a result, managers appear to act as if they can pursue value-destroying acquisitions with little concern about being disciplined by the market for corporate control,” Prof. Wang explains. 

According to Prof. Wang, the problem with the worker-manager alliance is a classic agency problem that takes place when the shares of a listed company is highly decentralized. When the manager of the listed company does not possess a large amount of the company share, he or she may be motivated to consider acquisitions that would provide them with personal gains at the expense of the company’s value or shareholders’ value. 

“Potential worker-manager alliances should be of concern to shareholders, even in economic regimes with relatively strong investor protections and weak employee protections. Specifically, we find that managers at U.S. firms with employee block ownership are more prone to make shareholder value reducing acquisitions, and ex post are less likely to be disciplined by the market for corporate control for their poor acquisition decisions,” says Prof. Wang.

Implications to Chinese Companies

Although the data of this research study are based on U.S. companies, Prof. Wang thinks that the results could have some implications for Chinese companies.

“The structures of U.S. listed companies and China’s listed companies are rather different. Usually, the shares of U.S. listed companies are more decentralized. As a result, the agency problems are more obvious among U.S. companies. However, the shares of China’s listed companies are more centralized, where the large shares are often held either by the government or by a family,” he explains.

“However, we observed recently that some China’s listed companies are considering setting up employee stock ownership plans. We hope our research findings would allow them to fully consider the impact of employee voting rights on the shareholders’ interest of their company,” says Prof. Wang.

You can watch the interview of Prof. Wang in Chinese here.